Image: John Schoen
By John W. Schoen Senior Producer
updated 7/27/2011 5:16:20 PM ET 2011-07-27T21:16:20

No matter what plan emerges from the debt talks in Washington, future Social Security benefits will be trimmed back. 

As Congress and the White House continue their dysfunctional dance toward financial Armageddon, the elusive, $4 trillion Grand Plan that would include Social Security and Medicare reform has fallen off the table.

But in the early stages of the budget battle, a series of proposals surfaced that provide clues to what broad reform of Social Security might look like.

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There’s widespread agreement that the program needs fixing. When first created in 1935, the earliest retirement age was 65, a year older than the average life expectancy. Today, with the average life expectancy at 79, beneficiaries can begin collecting at 62 and might well live for decades into retirement.

Meanwhile, the base of support from workers paying into the system has shrunk dramatically. In 1950, there were 16 active workers paying for every retiree. Today the ratio is three to one, according to the bipartisan National Committee on Fiscal Responsibility and Reform, a committee appointed by President Barack Obama and chaired by former Sens. Alan Simpson and Erskine Bowles to come up with a plan to cut the budget deficit.

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With more money flowing out and less money flowing in, and the baby boom generation hitting retirement age in force, the Social Security trust fund is expected begin shrinking by 2015. By 2037, the fund is projected to run out of cash, which means it could only pay out as much as it takes in. That would force immediate benefit cuts of about 25 percent if no changes were made before then.

Unless the program can be made to pay for itself, Congress would have to appropriate more than $13 trillion over the next 75 years to make up the shortfall, according to the Brookings Institution.

This wouldn’t be the first time Congress enacted major changes to get Social Security back on track. In 1983, a series of tax increases and future benefit cuts extended the program’s financial lifespan. The full-benefit age was lifted from 65 to 67, a portion of benefits were made subject to taxes and cost of living adjustments were delayed by six months. The overall impact was to cut benefits for a current retiree by about 19 percent, according to the National Academy of Social Insurance.

None of the current proposals envisions a cut in current benefits. But they all employ a mix of future cuts, taxes and changes in the cost of living formula.

HIGHER TAXES: As recently as the 1980s, the Social Security payroll tax covered roughly 90 percent of wages, according the Simpson-Bowles commission. But as wages above that cap have grown faster than the cap, the proportion of overall wages has fallen. Today, only 86 percent of wages are collected; by 2020 that will fall to less than 83 percent. The commission recommended gradually raising the cap to restore that 90 percent coverage by 2050. That would mean raising the cap to $190,000 in 2020, compared to roughly $168,000 called for in the current law.

RAISE THE RETIREMENT AGE: There are various proposals, but they all reflect the reality that life expectancy has risen since the program was created 75 years ago — and continues to rise. The age for eligibility already has risen to 67 for anyone born after 1960. Some proposals suggest moving the full retirement age to 70 and lifting the early retirement age for partial benefits — currently 62 — to 64 or 65. Others also include benchmarking future increases in the retirement age to advances in longevity.

CHANGE COST INDICES: Annual cost-of-living increases are based on the government's Consumer Price Index, which also is used in many government and private labor contracts to set pay levels. One commonly mentioned proposal involves using an alternative version of the CPI (called the “chained” index) that takes into account changes in consumer habits as prices rise. For example, if beef prices rise, and consumers switch to cheaper chicken, the chained index would reflect a slower increase in costs. Opponents argue that the chained CPI ignores the impact of rapidly rising health care costs, which hit older households harder and do not offer easy substitutions.

CHANGE THE BENEFIT FORMULA: Benefits for new retirees are based on their wage history, using a formula that takes wage inflation into account. Because wages have historically risen faster than consumer prices, some analysts argue that indexing benefits to wage gains tends to increase benefits slightly faster than living costs over time.

SLOW BENEFIT GROWTH FOR WEALTHY RETIREES: Changes in benefit formulas could also result in slower gains for new retirees on the upper end of the income ladder. Under the current formula, benefits are based on a percentage of lifetime wages. Changing that formula could slow benefit increases for top wage earners, who currently pay taxes only on their first $106,800 of income.

EXTEND BENEFITS FOR THE POOR, “VERY OLD”: Not all proposals would save money. One of those would increase benefits for retirees after 20 years. The proposal seeks to address the rapid expansion of people living to 85 and beyond who are in danger of outliving their retirement savings. The Simpson-Bowles proposal, for example, includes a “20-year bump up” that would add 5 percent to a retiree's paycheck 20 years after they begin collecting benefits.

Another proposal would increase benefits for low-wage workers by creating a new “minimum benefit” equal to 125 percent of the poverty rate, phased in by 2017 and indexed to wages after that. The minimum would be phased down for workers with less than 30 years and more than 10 years of employment.

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